The dollar has recovered as markets await the latest FOMC meeting, but can the Fed live up to its more hawkish rhetoric?
Markets on watch for hawkish Fed
The change in language by the Federal Reserve (Fed) in recent months has been startling.
From regarding inflation as ‘transitory’ (a term never properly defined, and thus heavily mocked), the world’s most important central bank now appears to be determined to rein in its loose monetary policy, on both the interest rates and quantitative easing (QE) fronts.
US consumer price inflation (CPI) has clearly surged, as the chart below shows, hitting its highest level this century.
How much of this is down to the reopening of the economy following the pandemic remains to be seen.
Even ‘core’ CPI, which excludes food and energy, is at a multi-decade high. The pressure on the Fed to act is intense.
GDP growth continues
The economic rebound is still in place. While growth in the third quarter (Q3) slowed from Q2 2021, it is still moving at a healthy pace, and is stronger than the pre-crisis readings. This, along with CPI, bolsters the argument for an end to ultra-loose policy.
Dot plot points towards higher rates
Everyone on the Federal Open Market Committee (FOMC) it seems is keen to raise rates, or thinks that the time has come to think about raising them.
The most recent ‘dot plot’ shows that the majority of members think rates should be around 1% for 2022, moving steadily higher as the years go on.
Markets are expecting around four interest rate hikes this year, while an end to QE and a slow reduction in the balance sheet are also on the cards. But the Fed will struggle to exceed expectations on the hawkish side this time around, having already dramatically shifted its views since early December. Markets have already reacted to these moves, causing a drop in stocks and further dollar strength.
But much of the outlook at this week’s meeting appears to be priced in. Markets are adjusting to the changed outlook, and unless the Fed talks up the chances of a 50 basis-point increase in March then ‘sell the rumour’ and ‘buy the fact’ might predominate in equities, with the reverse the case for the dollar.
Dollar index – technical analysis
After drifting down throughout December and early January the dollar index has begun to revive. A trip below the 50-day simple moving average (SMA) saw the price drop to a two-month low around 94.60, but the 100-day SMA provided support and a bounce materialised.
Fresh gains have taken the price back to the 50-day SMA, and it is now testing both this and trendline resistance from mid-December. A daily close above 96.03 would mark a fresh bullish development and put the highs of November 2021 back in view once again.